When people talk about income shares and growth shares, they are not talking about two formally different types of shares. Instead, the terms relate to what is widely seen as the investment case for a company.
British American Tobacco, for example, has been growing sales in recent years. But as it operates in a mature industry and boasts a 6.5% dividend yield, it is typically seen as an income share. By contrast, Tesla pays no dividend and operates in an industry expected to see demand strengthening quickly in coming years. Its sales have soared in the past few years. It is known as a growth share.
I hold both income and growth shares in my portfolio. I like the dividend potential of income stocks. But I also think putting money into some growth stories could help me build a future nest egg. Here is why.
Big potential – and uncertainty
All businesses have an uncertain future. But I think that is especially true of growth shares.
Take the example above. Cigarette sales are declining, which is a big risk to sales and profits at British American Tobacco. But in this long-established industry, in broad terms I feel I know what to expect from owning shares in a tobacco company like British American. There may be some surprises, but the economics and outlook of the tobacco industry overall seem fairly observable to me.
By contrast, the electric vehicle industry may well see far more dramatic sales growth in coming decades than tobacco. But it is not clear who the winners will be and whether they will include Tesla. The long-term economics are also very uncertain. If electricity prices get very high, for example, maybe demand for electric vehicles will fall.
That is typical of leading growth shares in my view. The opportunity may turn out to be huge (imagine investing in Apple in the early 1980s or Amazon 20 years later). But so too is the uncertainty.
Choosing carefully
So although I think buying into growth companies today could help provide me with a future nest egg, it depends on how I go about it.
If I had £5,000 to invest I would be sure to diversify. For example, I could invest £1,000 in each of a handful of growth shares.
But that does not necessarily mean I will be successful – I could choose five duds, after all. Many growth companies look very promising but run out of money before they make a profit. That can be costly for shareholders. So I would pick the shares in which I invest carefully.
Finding promising growth shares
In that sense, I look for many of the same characteristics in growth shares that I do in any other type of shares.
Does a company operate in a sector I expect to experience large customer demand in future? Does it have some sustainable competitive advantage that can help set it apart from the pack? Does its business model make sense to me? Is debt manageable from expected profits?
I could do very well investing in growth shares — depending on which ones I buy!
